Presentation Transcript

Capital Budgeting Techniques:

Proposed Project Data:

Proposed Project Data X is evaluating a new project for her firm. She has determined that the after-tax cash flows for the project will be 10,000 ; 12,000 ; 15,000 ; 10,000 ; and 7,000 , respectively, for each of the Years 1 through 5 . The initial cash outlay will be 40,000 .

Payback Solution :

PBP Strengths and Weaknesses:

PBP Strengths and Weaknesses Strengths : Easy to use and understand Can be used as a measure of liquidity Easier to forecast ST than LT flows Weaknesses : Does not account for TVM Does not consider cash flows beyond the PBP Cutoff period is subjective

IRR Solution (Interpolate):

IRR Acceptance Criterion:

IRR Acceptance Criterion No! The firm will receive 11.57% for each dollar invested in this project at a cost of 13% . [ IRR < Hurdle Rate ] The management of has determined that the hurdle rate is 13% for projects of this type. Should this project be accepted?

NPV Acceptance Criterion:

NPV Acceptance Criterion No! The NPV is negative . This means that the project is reducing shareholder wealth. [ Reject as NPV < 0 ] The management of Basket Wonders has determined that the required rate is 13% for projects of this type. Should this project be accepted?

NPV Strengths and Weaknesses:

NPV Strengths and Weaknesses Strengths : Cash flows assumed to be reinvested at the hurdle rate. Accounts for TVM. Considers all cash flows. Weaknesses : May not include managerial options embedded in the project. See Chapter 14.